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Things I wish I knew when I started earning

Financial life lessons can be expensive. But you don't need to personally experience hardships to learn these lessons. Here are some common pitfalls, and how to avoid them.

March 21, 2022 / 06:39 PM IST

When we first start earning, it can be a little dizzying, right? That first salary is a definite jump up from whatever we earned from one-off part time jobs, and it's on a whole other level compared to pocket money! It messes with our minds a little bit, and we grossly overestimate what we can do with it. Throw in a credit card into the mix and what we have is a young person who hasn't learned financial discipline yet, with access to vast amounts of credit (or so it seems at the time!). It's basically the same situation as a kid in a candy store. 

Is it any surprise that so many of us have burned our fingers in this situation? Wish you knew everything you need to know about missed payments, spiralling debt, bad credit scores, and inability to raise credit when you really need it… but without the stress of going through it? Look no further. 

In this article, we're looking at the common mistakes we all make when we first avail credit, and how to avoid them. 

Making only minimum payments on credit cards

It's tempting, right? You went a little (or a lot!) overboard and now you have this frightening bill. However, there is another manageable looking amount on this bill: the minimum amount due. That looks like something you can pay, and it wouldn't be so bad if you just paid this amount… right? 

Unfortunately, no. If you pay only the monthly 'minimum due amount', which is generally about 5 percent of the total amount of the bill, to the lender/issuer, you still owe 95% to the credit card company plus interest! You see, a credit card’s interest rate is the price you pay for borrowing money. These are stated in monthly rates, so they look small. 3.5% doesn't look like much, does it? But the number you should be looking at is Annual Percentage Rate, which is the amount you pay in a year. What does that 3.5% monthly rate look at as an APR number? 

42%. 

But you have 50 days of credit, right? Not really. Not if you have a single rupee due. Only if you pay the total amount due on your credit card before or on the due date, do you enjoy the interest free period. Credit card interest is calculated on the outstanding amount. Which means that when you pay only the minimum due, you're creating outstanding amounts, which means you'll pay interest. The way the interest calculation works is this: 

Let's assume you made a purchase of Rs 10,000 on January 15th, and your bill was generated on February 1st. Payment due date is 18 days later, on February 18th. Your minimum amount due is Rs 500 (5% of 10,000), which you paid on February 10th. The next bill will be generated on Feb 28th, and to keep the calculations simple, let's assume you'll make no other purchases. Let's also assume your credit card charges only 2.5% interest. 

This is what your interest charges will look like: 

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To this, GST at 18% is levied, amounting to Rs 65.17. This will be added to the outstanding amount so in your statement on March 01, 2021, the Total Amount Due will be Rs 9,927.23 (Rs 9,500 + Rs 362.06 + Rs 65.17). See how quickly you came back to the original Rs 10,000 despite paying minimum amounts? (If you want to see the detailed math, go here!)

Now, this is a single purchase. Most of us don't stop using our credit cards after making a single purchase! Which means that we end up in what is called a debt spiral: each month, our minimum amount due gets larger, our total bill amount gets scarier and scarier, and we find it harder and harder to keep up with our bills.

How do you get out? 

Unfortunately, the only way to take control of debt is to pay it down. The first step is to stop adding to your debt burden. You could tighten your belt, and start using what you have in the bank to pay for the things you need, and only use the card for genuine emergencies. Once you can do that, begin paying a little more into your cards each month. Remember, each time you pay more than your minimum balance, it brings down the principal amount your interest is calculated at! You can chip away at it by making small payments (whatever you can afford). Of course, you make much more of a dent by paying in bigger amounts, so consider restructuring your finances in a way that you can pay a little more back each month.

However, if the above isn't an option, then you should consider looking at lower interest products like converting purchases to EMIs or availing personal loans. No personal loan interest rate is as high as credit card interest.

Availing several loans at once 

Personal loans can be great to tide over temporary shortages, or when you urgently need money to pay for emergencies. However, using it as a go-to method can be problematic as having multiple loans means managing multiple EMIs - which may or may not come at the same time. It's an easy trap to fall into: say you've just moved to a new apartment, and this one doesn't come with furniture. You buy these on a manageable looking EMI. In fact, you're surprised at how much you were able to get for just Rs 7,000 a month! 

The following month, you decide to replace your fridge. Same deal: you're paying just Rs 4,000 a month for this great fridge! The following month, you decide to treat yourself to a gym membership and an athleisure wardrobe. You were even able to convert all those purchases at the sports store into EMIs on your credit card! Just Rs 3,000 a month for the perfect gym wardrobe! It's just a little bit extra, you'll manage, right? 

The month after that, you realise you're in trouble. That's Rs 14,000 a month, fixed, that you're committed to now. The fridge EMI hits your account at the end of the month, when your bank account is running on fumes. In case you miss the payment now, you'll have a bigger problem next month with interest and late fees! On top of that, you've hurt your credit score (over a fridge!). 

What is your credit score? We'll come to that in the last section. 

How do you get out? 

Of course, the best thing is to make a budget and stick to it, but we get it why that gets derailed sometimes! If budgets are a struggle, then one of the simplest things to do is request a change in the EMI dates - pay out all your EMIs at the beginning of the month. That way, you know exactly how much money you have left for spending! Now, exercise financial discipline. Remember, the EMIs won't last forever! If you do come into some money, check if you can pay out one of the EMIs (go after the one with the highest interest rate first) as prepayments will reduce future burden. If that isn't allowed, then park this money in a separate account (if you can), and use it as your emergency fund - just so that your monthly budget isn't thrown for a toss by an unexpected/emergency situation. 

Spending in anticipation of a raise. 

It's tempting to think that the annual bonus is going to solve all your problems. You'll clear your credit card bills, pay off all the outstandings on your loans, and of course, buy yourself a little something special to celebrate. And since you have ready credit now (your credit card), you can spend now, because the money is coming, right? 

Wrong! You're spending money you don't have yet. What happens if the bonus doesn't come? Or doesn't come in time? Or is less than you expected? Or what if you miscalculated how much tax you'd pay? Wait. Let it hit your account, and then figure out what you'll do. Better informed people make better decisions! And yes, if you have any outstandings on your credit card, pay into that first. Your future self will thank you! 

Missing just one payment is okay, right?

As we've seen, it can be easy to miss a credit card payment or loan EMI if you’re juggling a half dozen different bills all with different due dates, and you haven’t yet set up autopay. Unfortunately, a missed payment can come with expensive consequences, as we saw earlier in this article. Each missed payment incurs a late payment fee, penalty interest rate and damages to your credit score. 

Settlements and how they impact credit scores 

Clearing your settlements is the best way to fast track your credit score's recovery. What are settlements? It's when your bank (or financial institution) makes you an offer that allows you to pay less than what you owe. They also offer friendlier payment arrangements. Settlements can be tempting, especially when you're feeling overwhelmed with debt. However, settlements significantly impact your credit score, so these should be your last option. First explore if you can convert any purchases or outstanding amounts into EMIs. Also, in the event you choose settlements, it's important to understand how they work, so you can manage both - your financial health and your credit score. 

When availing a settlement, always find out how to pay off your bill in full and change your status from ‘Settled’ to ‘Closed.’ Yes, right now you're in financial trouble. But that won't always be the case. Once you've recovered, it is a good practice to pay your debts in full. Remember, a ‘Settled’ status still has a negative effect on your credit score because you haven't paid in full. Talk to your bank or financial institution (now or once you have more money) and agree on a mutually acceptable amount that will allow you to convert it to a ‘Closed’ account. Make the payment and then ensure you collect your no-dues certificate from the credit card provider as well as a written confirmation of the account closure. This is how you recover financially, and also bring your credit score back to a healthy place. 

Understanding the importance of your credit score 

What is your credit score? Simply put, it's a measure of your creditworthiness. Credit bureaus aggregates your cards and balances from various financial institutions and assesses multiple factors to determine your credit score.  

Why is it important? Because each time you miss a payment, your score dips a little. The lower your score, the harder it is to avail any kind of credit. Your credit score even determines what interest rate you are offered when buying a house, a car, or even availing a personal loan. In fact, it can even impact your insurance premiums. The lower your credit score, the worse the rates you're offered, because the risk of loaning money to you is considered high. Companies compensate, by increasing interest. 

This is why it is so important to keep track of your credit score. The OneScore app makes it super easy to check and manage your credit score. And it's free! The app tells you your credit score according to two credit bureaus - Experian and CIBIL, and also gives you personalised recommendations on how to improve your score. Even if you've missed a payment (or two, or five!) in the past, there are things you can do to recover your credit score! Just follow the app recommendations. 

Conclusion

We've all been there. It's easy to overextend ourselves financially when we're still getting used to having and spending our own money! However, this doesn't need to become something that harms your future. You're allowed to make mistakes! And you can recover! Good spending habits are a normal outcome of getting into debt - we all get there. Once you've pulled yourself out of debt, you will be extra cautious next time! 

Paying off a big debt supports financial freedom in more ways than one. One, you gain the discipline of spending within your means, and generating forced savings (which go into your debt payments). Two, it gives you freedom once you're paid up - no more debt weighing you down! Three, your financial discipline helps you save and invest, creating future cash flow for you to work with. Four, your credit rating improves, and new lines of credit open up to you, at a time when you've learned how to manage credit! 

So, even if your finances and credit score don't look great today, it's okay! You're learning. Think of managing money like a muscle. The more you use it, the stronger it gets. And as for your credit score, you've got the OneScore App on your side. Just remember to ask yourself #ScoreDekhaKya during your monthly budgeting exercise, and you'll be well on your way to financial recovery and financial freedom. 

For more articles, information and tips, visit our page #ScoreDekhaKya.

Moneycontrol journalists were not involved in the creation of the article.
Tags: #Features
first published: Mar 21, 2022 06:24 pm